...you don't have to be a forensic accountant to spot trouble on a financial statement. Here are several line items on a balance sheet you should focus on to gauge a company's strength, including inventories, free cash flow, and accounts receivable.Inventories. Typically, inventories should rise at about the same pace as sales. If a company's inventories are growing faster than sales or expected sales growth, it's a clue that products aren't moving. In that case, gross margins could get squeezed.Free Cash Flow. A significant drop in free cash flow may occur when a company makes a big acquisition, buys new equipment, or throws money behind a new product. Free cash flow is cash flow from operations minus capital expenditures. Why is free cash flow important? It's the money left over at the end of each quarter after all the bills are paid. A company can use this money to pay a dividend, trim debt, make an acquisition, or buy back stock. "You want to see cash growing or what the companies are doing with the cash," said Eric Heyman, director of research at the Olstein Funds. "Companies with cash on their balance sheet have lots more flexibility than a company that doesn't, regardless of economic conditions."Accounts Receivable. Another area to check is accounts receivable, or payments due from customers. In addition to how much a company is owed, receivables also tell when it expects to be paid. To make this calculation, divide revenue by the number of days in the reporting period. Then divide the figure given for receivables by this result. What you don't want to see is receivables rising at a much faster pace than sales. This suggests a company is shipping too much product into the channel and possibly extending collection payment terms.Always Making the Number. Does the company have a history of meeting the consensus analyst earnings target each quarter? Dell Inc. had that reputation...on July 22 [it] agreed to pay $100 million to settle the Securities and Exchange Commission's civil charges that it used improper accounting to cover earnings shortfalls.Continual Restructuring Charges. Middleswart of Behind The Numbers says restructuring charges tell him a company made a mistake, especially when they come up often. "They are telling you they screwed something up," he said.Thickness Test. Can't lift the 10-K or 10-Q from your mailbox? Printer runs out of paper? This is another sign. Sure, a company's 10-K is likely to be larger than normal if they've made a big acquisition or sold assets. Otherwise beware: "If it's a big fat one," Middleswart said, "you know there is something going on.
Monday, August 2, 2010
Given recent history's presumption of stock market growth without bound for economic reality I have set about learning the trickeries associated with balance sheet reporting.